Why America Needs a Stock-Market Crash

A week into the partial government shutdown, and there’s still no end in sight to America’s latest self-inflicted fiscal crisis. The two sides, in particular the House Republicans, appear to be getting even more intransigent, and the October 17th deadline for a possible breach of the debt ceiling is now looming. Having just returned from a long-ago arranged six-day trip to Europe, I thought I must have missed at least one significant effort to reach a resolution. In fact, practically nothing had happened since I left, save that both sides have continued to talk past each other. Absent an unexpected softening in attitudes over the next few days, it may well take some outside intervention to break the deadlock.

Had this situation arisen in the not-so-distant past, it’s conceivable that some older, wiser heads from both parties would have gotten together and hashed out a deal that allowed each side to claim victory. But given the G.O.P.’s lurch to the right, and the White House’s understandable reluctance to buckle in the face of reckless brinkmanship, such a statesmanlike solution is difficult to envisage. Something more drastic is needed, and my candidate is a stock market crash.

I’m not talking about a cruncher on the scale of Black Monday, in October of 1987, when the Dow plummeted by twenty-three per cent in a single trading session. (An equivalent move now would lop about thirty-three hundred points off the index.) But I am talking about something significantly bigger than the market slippages we’ve seen in the past few days. (The market fell by 136.34 points on Monday, and closed at 14,936.24.) How large it might be, nobody can say for sure. But if the market fell by, say, three or four hundred points for three days in a row, and then lurched down another eight hundred points, or even a thousand points, the effect would be salutary.

How can I say that? Tens of millions of Americans would grow alarmed about their 401k plans. On Wall Street, there would be margin calls, liquidity runs, and other disturbing developments that inevitably accompany market breaks. Rumors would start to spread about the health of various financial institutions. You don’t have to subscribe to a tail-wags-the-dog view of finance and politics to believe that this would lead to a rapid change of thinking, and of behavior, in Washington.

One reason that we can be confident that a shift would come about is that, just five years ago, something pretty similar happened. In September, 2008, at the height of the post-Lehman financial crisis, an unlikely coalition of conservative Republicans and liberal Democrats voted down Hank Paulson’s TARP bank bailout. Wall Street promptly went lulu, dropping almost eight hundred points in a day, and that did the trick. Despite some bleating and harrumphing, echoes of which we hear to this day, the House promptly reversed course and voted for the seven-hundred-billion-dollar bill that the Bush Administration had proposed.

Since 2008, of course, the House G.O.P. has gotten considerably more extreme, and it is now confronting a Democratic President rather than a Republican one. That’s why we might need an even bigger fall in the market than we had in 2008. In the face of a single day of heavy losses, the members of the G.O.P.’s Tea Party faction might well say “So what?,” and the Republican leaders might continue to cavil to them. What is needed is something genuinely frightening, which would give John Boehner and his colleagues a reason and a rationale for overruling the ultras.

It might seem a bit extreme to wish a big loss on the retirement accounts of America’s savers and investors, myself included. But taking a relatively modest hit now would be much preferable to allowing the House to posture and procrastinate for another couple of weeks. By then, the United States could be facing the prospect of a genuine run on Treasuries and the dollar—the result of which would make a thousand-point drop in the Dow look like a mere wobble.

To be sure, things have come to a pretty pass when a nation that thinks of itself as the world’s greatest democracy has to rely on a conniption in the markets to discipline its unruly and irresponsible representatives, but that’s about where we are. As evidenced by what happened in 2008, it’s where we’ve been for some time. Back then, it was perfectly clear that some sort of government bailout was necessary to arrest the financial panic and head off a possible depression. But because such a course of action was ethically and morally toxic, our divided and fragmented political system couldn’t carry it through until the markets intervened.

Today, the situation is less grave than it was in September, 2008, but it’s fundamentally similar. In order to maintain a functioning government, Congress needs to finance the programs it has enacted. In order to protect the good standing of the United States and underpin the reserve status of the dollar, the Treasury Department needs to be able to raise money that can be used, among other things, to pay the country’s creditors. A bit of bedlam in the markets could help accomplish both of these tasks. If, in the wake of a mid-sized Wall Street crash, White House officials and House Republican leaders did sit down to talk, it’s practically inconceivable that they wouldn’t reach an arrangement about the debt ceiling as well as the shutdown: U.S. investors and foreign creditors would demand that the two things were settled simultaneously.

The danger, of course, is that things could get out of hand. Once a big financial market, such as the stock market, starts to break down, there’s no saying where things can end up. If the falls aren’t addressed promptly, self-reinforcing cycles can quickly develop, leading to more selling and more panic: that’s what we saw in 2008, when the market for subprime-mortgage bonds imploded.

In this case, though, there is less danger of a self-reinforcing collapse. What we are dealing with isn’t the bursting of a speculative bubble or some other economic pathology: it is posturing and mischief-making on the part of a relatively small group of Washington politicians.

Once the markets started tanking, investors, the banks, and the media would besiege Congress for action. The political environment would change drastically. Refusing to acknowledge reality, including the reality that every country has to pay its creditors or face ruin, would no longer be an option. Within days, or even hours, the two sides would come up with some face-saving device to calm the markets. (Finding a more lasting solution would still be a big struggle.)

To sum up, Congress needs adult supervision. Since the President can’t provide it and the Republican leadership won’t, the market might well have to step in and do the job. Such a resolution wouldn’t be pretty, but history suggests it would be reasonably effective. And once the immediate crisis was resolved, the market would probably recovery pretty sharply.